The JOBS Act and Private Placement Memoranda

The JOBS Act Lifts the Ban on General Solicitation for Private Capital Raising

The JOBS Act lifts the ban on general solicitation and advertising for private capital raising using Private Placement Memorandum (PPM) sales. U.S. companies raise billions of dollars every year through private offerings under Securities and Exchange Commission (SEC) Rule 506 of Regulation D, which gives issuers a safe harbor from Securities Act registration requirements.

Before the JOBS Act there has been a long-time ban on “general solicitation and general advertising” of such deals. Typically, that means companies must go to existing investors to raise money or work with a broker-dealer that has preexisting ties to the sophisticated investors allowed to invest in private placements. The JOBS Act lifts this ban.

Reasonable Steps to Verify Accredited Investor Status

In its proposed rule issued in August 2012, the SEC declines to define what actions suffice as reasonable steps to verify accredited investor status or in fact that such steps would be necessary in every case. However, in response to numerous comments on the issue, the SEC final rule requires that an Issuer take reasonable steps to verify that purchasers are accredited. Moreover, the SEC included a non-exclusive list of methods that issuers may use to satisfy the verification requirement. Note that the verification requirement is separate from the requirement that all investors in fact be accredited.

According to the SEC, “whether the steps taken are ‘reasonable’ would be an objective determination, based on the particular facts and circumstances of each transaction.” Among the factors that issuers should consider under the fact and circumstance analysis are:

a. The nature of the purchaser and type of accredited investor they claim to be. For instance, if the purchaser is claiming that they are accredited because they are a broker dealer registered with the SEC, verification could be a simple check on the FINRA website. Of course, the hardest status to verify will be natural persons claiming they meet the net worth ($1 million) or income ($200,000 a year) requirements. Accordingly, as set forth below, the SEC final rule sets forth non-exclusive methods that issuers may use to satisfy the verification requirement.

b. The amount and type of information that the issuer has about the purchaser. Clearly, the more information, the better. The SEC lists the obvious (W-2; tax returns; letters from a bank or broker dealer). Moreover, although not required, it is assumed that an issuer should at least conduct a check of publicly available information.

c. Nature and terms of the offering, such as type of solicitation and minimum investment requirements. The example proffered by the SEC is an offering conducted by soliciting preapproved accredited investor lists from a reasonably reliable third party, vs. open-air solicitation via social media or television or radio advertising—the latter, of course, requiring greater verification than the former. The SEC highlights the obvious, such as that the higher the minimum investment required, the fewer steps an issuer would need to take to verify accreditation.

After consideration of the facts and circumstances of the purchaser and of the transaction, the more likely it appears that a purchaser qualifies as an accredited investor, the fewer steps the issuer would have to take to verify accredited investor status, and vice versa. Moreover, where accreditation has been verified by a trusted third party, it would be reasonable for an issuer to rely on that verification.

The more information an Issuer has evidencing that a prospective purchaser is accredited, the fewer additional steps it will have to take to verify the status, and vice versa. Examples of the type of information that Issuers can review and rely upon include:

(i) Publicly available information in filings with federal, state and local regulatory bodies (for example: Exchange Act reports; public property records; public recorded documents such as deeds and mortgages)

Regardless of the methods an issuer uses to verify accredited status, they should keep adequate and complete records. If the exemption is challenged, the burden is on the issuer to prove that under the facts and circumstances of their particular offering, they took reasonable steps to verify and they reasonably believed that an investor was accredited at the time of the sale. However, although the rules do not address the issue, the SEC is cognizant of the privacy concerns raised by having issuers obtain and maintain personal financial records from investors.